“Corporate profits declined -4.7% annualized last quarter, and compared to a year ago, they were down -4.9%. In fact, profits have declined on an annual basis for the last five consecutive quarters, an extremely rare occurrence outside of recession.”

The thinking is this: Companies see their profits and profit margins declining and in order to stem the tide, they cut back on costs. Cutting back on costs includes no longer hiring workers and eventually laying off people. This gets Americans concerned about their personal finances, so they spend less, which hurts economic growth. This becomes a vicious circle and ends in a recession.

One of the arguments against this bearish line of thinking has been that the margin decline was concentrated in the energy sector, and that as oil prices recovered from earlier this year, when they were at their lowest point in over a decade, the margin decline would ease.

“Importantly, the decline in corporate profits is no longer just due to the well-advertised weakness in the energy and export sectors,” said the note.

“Case in point, pre-tax domestic corporate profits (without capital consumption adjustment) excluding the energy sector and Federal Reserve Banks were down -5.2% over the four quarters ending in Q1 2016.”

source

Deutsche Bank

LaVorgna noted that increases in hiring and wages along with declining profits are pressuring margins per worker, his preferred measure of profit margins, for the largest corporations. Of note, net trailing 12-month margins have been on the decline as well and are negative year-over-year according to FactSet.

The Deutsche Bank economist highlights, as we have before, that in every business cycle since World War II a decline in profit margins has come before a recession. Typically, the decline precedes a recession by eight or nine quarters, though it can be as long as 16. This signals to LaVorgna that a recession is nearby.

“The current business cycle is already the fourth longest in the post-WWII period, and as we mentioned before, productivity growth has been abysmal,” said the note.

“Hence, there is little cushion for the economy to absorb any negative endogenous shock. Moreover, the corporate debt-to-GDP ratio suggests that imbalances are building.”

To be fair, both margins and overall profits are showing some improvement. In fact, earnings per share for the S&P 500 companies declined by only 1.8% in the second quarter according to S&P Global market Intelligence, much better than the 5.8% decline expected, and earnings growth is expected to go positive in the coming quarters.

Additionally, both margins and overall profits are coming down from record highs and still remain well above their pre-recession average.

Despite this, unless margins recover, their decline will be a constant refrain for anyone forecasting a recession in the short-term, as LaVorgna has been for a while now. Whether or not that comes to pass remains to be seen.